The Emerging Market Bond Rally: Optimism or Doom?

By Ben Levisohn

Emerging-market local-currency bond funds are outperforming their benchmark by 0.34 percentage point so far this month, according to Citigroup. And while that might not seem like a lot, its in the 94th percentile during the past three years, say Citi’s Chintan Gandhi and Dirk Willer.

Reuters

That means that the funds were probably loaded up on the riskiest assets, Gandhi and Willer note. They do not, however, see this as a reason for concern. During the past 36 months, there have been seven months with similar success by fund managers, and in six of those months the market was positive. What’s more, in five of those months emerging-market bonds performed better than the average during this period.

“This could be because when real money investors take positions, they have longer horizons and more staying power than the typical fast money investor,” Gandhi and Willer write. “In such a case, they are unlikely to pare down positions until there is a large change in their views.”

Not everyone is convinced. State Street’s Fred Goodwin, who calls emerging-market bonds “the most Unsafe Haven,” notes that currency volatility is heading higher in developed markets–and that it’s only a matter of time before it shows up in emerging-market FX as well.

“It will not be long before nervous investors decide they must hedge,” Goodwin writes, by buying credit-default swaps, selling emerging-market currencies or emerging-market equities. “The exit door here is so small that an anorexic amoeba would find it difficult to fit through,” he says.

The Market Vectors EM Local Currency Bond (EMLC) exchange-traded fund has returned 0.15% so far this year through Jan. 18, and has dropped 0.31% today.

So which is it: More pain or more gain?

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